Primark sells bargain-priced clothes. Its products may not exactly be known for their durability, but its owner, Associated British Foods (LSE: ABF) (AB Foods), has endured for decades. And like its clothes, AB Foods’ shares look very cheap. In the last ten years, the company has become more profitable and executed its strategy well. Yet its shares have nearly halved. Even having fallen so much in the past ten years, however, over 30 years the shares are still up 14-fold. The company has been a great British success story and has the potential to carry on growing well into the future. Now is the time to consider an investment in this great business.
The cheap valuation seems nonsensical. It is probably a result of its unusual corporate structure, which has rendered it arbitrarily uninvestable to certain types of passive investor. Essentially it is a family business, with the Weston family maintaining effective control. As passive investment strategies have come to predominate in finance, shares in this type of conservatively managed family business are often left behind. This leaves a great opportunity for private investors.
A brief history of Associated British Foods
As well as selling clothes via Primark, Associated British Foods is a multinational food producer with operations running from production and processing of raw materials through to the making and marketing of branded products such as Twinings and Ovaltine. It operates five business divisions, with Primark being by far the largest, making up roughly half the revenues and profits.
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Grocery is the second largest part of the business. It produces branded food sold in supermarkets in 120 countries. UK consumers will be familiar with products such as Ryvita and Patak’s. The other three businesses are AB Agri, which produces animal feed additives such as vitamin mixes for livestock; ABF Sugar, which produces roughly 2% of the world’s sugar and employs 29,000 people globally; and the Ingredients business, which makes bakery products.
Given the dominance of Primark clothing across the five businesses, you could say that the word “Foods” in the company’s name is odd. You could say the same for “British”. AB Foods was founded by a wealthy Canadian businessman, Willard Garfield Weston, in 1890 in Canada, where it remains one of the country’s largest businesses. The “British” in the name came in 1935 when the company ventured into Britain. It was founded here as Food Investment Limited before changing its name to Allied Bakeries. The current name was adopted in 1960.
Fleeing the Great Depression
The move to investing in the UK for the already wealthy and respected Canadian businessman was driven by the Great Depression. During the early 1930s, wheat prices collapsed and Canadian farmers were struggling to stay afloat. Sometimes it is assumed that the world economy was roaring in the 1920s and in a severe recession in the 1930s. This is not so. The UK economy in the 1920s was held back by strikes and depressed economic conditions. As the US entered its Great Depression in the 1930s, the UK emerged from its slump into a period of relative boom.
Willard devised a plan to revive parts of the Canadian economy by selling Canadian wheat to the UK. This had the advantage that Canadian wheat was much cheaper and generally of higher quality than that of the UK. Nevertheless, the plan would have probably failed had he simply intended to sell to British companies because a mixture of patriotism and mistrust would have turned away many potential customers. This eventually led him to the idea to set up a UK company to be the customer of Canadian wheat.
Initially, Willard bought small companies under the umbrella of the Canadian holding company. These were often small biscuit manufacturers and bakeries with antiquated factories. Once bought, they were combined into larger operations and modernised. In 1935, he moved to the UK with his family and formally founded the company that would become AB Foods. By the time the UK was fighting World War II, Willard was executive chairman of two large and expanding food production empires as well as the MP for Macclesfield. As war turned to peace, the companies continued expanding in their respective markets, with AB Foods focusing on biscuits and bread.
Primark: Branching out into clothes
The idea for Primark came about in 1969 when an Irish entrepreneur called Arthur Ryan opened a clothes store in Dublin called Penneys on behalf of Associated British Foods. Having proved its success, it expanded to other Irish cities before moving into the UK in 1973. However, the Penneys brand name couldn’t be used outside of Ireland because the American retailer JCPenney owns it elsewhere. Eventually it was agreed that Irish stores could still be called Penneys, but in all other countries the name Primark would be adopted.
Today, the Primark business remains an Irish-headquartered retailer that is wholly owned by AB Foods. The British Isles remain the largest market for Primark, with 194 of its 451 stores located in the UK and a further 38 Penneys in Ireland. Just over half of all the stores are situated across the rest of Europe and North America, with 19 of the 22 stores opened last year in markets outside the UK and Ireland.
How Associated British Foods’ shares have fared
The share price of the company peaked in December 2015 at 3,600p. Since then it has been on a near uninterrupted decline. Having fallen to 2,600p at the start of the Covid-19 pandemic, the shares reached an absolute bottom at the end of 2022 at a level slightly higher than 1,200p. A period of respite ensued, but once again the shares have been waning. They are today barely half the price they were at in 2015.
AB Foods is a conglomerate in that it operates a great many businesses across its five divisions, covering a range of disparate activities. The consequence of the conglomerate structure is that there will always be parts of the business that are going through difficult periods. Equally, however, there will be parts that are doing well. In that sense investors in the company effectively gain a portfolio of businesses in a single stock. Taken as a whole, in contradiction of the share price, progress in the business has been very positive.
The long-term progress of the business can be seen when you compare how it was doing in 2015 when the shares were at their highest with how it is performing today. Back in 2015, ABF Sugar was the part of the business that was doing particularly poorly. Generally, it is difficult to operate in the sugar industry because many countries consider sugar a vital economic commodity. This means production subsidies are common, so the industry is prone to prices that are too low to make an adequate return. In 2015 the division posted a 2.4% return on capital, generating a measly £43 million in profit from a near £2 billion asset base. For context, £2 billion in a bank account would have generated a similar amount without having to take as much risk. This £43 million represented an 80% decline on the previous year.
The other three food businesses (Grocery, AB Agri and Ingredients) were all doing well. Together they generated a profit of £421 million from a combined asset base similar to ABF Sugar. They were nearly ten times as profitable. These businesses operate in less challenging sectors to ABF Sugar and are therefore fairly consistent in their returns. Collectively these businesses grew at 17%, which, although good, was not enough to offset the decline in ABF Sugar’s profits.
Primark picks up the slack
One might assume that if the four food divisions were actually generating lower profit than the year before, the shares would be weak. This was not so thanks to growing excitement about the growing Primark business. Having built up to the point of near saturation in its home markets, there had been concerns that Primark might struggle in foreign countries, especially the notoriously tough US market. But 2015 represented the year in which Primark reached scale internationally and was beginning to meaningfully contribute to company profits.
The most notable announcement that year was the successful opening of the first store in the US. Primark was by then generating £673 million of profits and was for the first time more profitable than all the food businesses combined. In the consciousness of investors, the group had transitioned from being a stodgy, albeit well-run food business into a fast-growing clothes retailer with huge potential. In the nine years since then, only the smallest business (AB Agri) has fallen in profits. All the other parts have grown substantially, including ABF Sugar, which last year made almost 400% more than in 2015. The Grocery and Ingredients businesses have nearly doubled in size, while the Retail operation is 65% more profitable than it was. Taken as a collective, the company is doing well and profits are up 84% to roughly £2 billion. Yet having been on a price/earnings (p/e) ratio of more than 30 in 2015, and having spent much of its existence on a p/e of around 16, today, the shares trade at less than ten times earnings.
Why are shares in Associated British Foods so cheap?
The reasons for this stark cheapening in the shares are at least two-fold. First, although the growth over the intervening nine years has been consistent and steady, it has been perhaps slightly less than hoped for. It was hoped that Primark would roll out its store expansion more quickly having cracked the massive US market.
Nevertheless, markets are fickle and often irrational. The potential for expansion remains and is being steadily exploited. In 2015 there was one store in the US. Today there are 27, with six opened last year. There are 232 in the UK, so the potential scale in the US could be many multiples of the current size. Progress has been slow, but slow progress is still progress.
The second reason the shares are cheap is because of the way the stockmarket structure has changed over time. Stockmarket investment at a professional level is increasingly “passive” – that is to say stocks are not being picked individually, but rather entire indices are bought by funds seeking to track their returns. The consequences are profound. First, valuations of companies are not a factor in determining whether a share is bought, so cheapness can persist and become extreme – as can expensiveness. Second, many passive investment vehicles use basic rule sets to ensure their products appeal to as many investors as possible. These include stipulations of market liquidity – the value of shares traded daily – and restrictions according to whether the companies meet environmental, social and governance (ESG) criteria.
AB Foods’ shares are disadvantaged by these stipulations. It is still a family business with 54.5% of the shares held by the Weston family. This means the shares are a lot less liquid than other similarly sized businesses, which reduces the amount passive investors buy. More importantly, because the family has effective control of the group (the current CEO is Willard’s grandson, George G. Weston), it falls foul of the governance part of ESG. This for many passive investors precludes its purchase entirely. This has led to a situation where the shares have consistently become cheaper.
In the long run a cheap company will not stay cheap, especially one with well-run, diverse operations such as AB Foods. It might require patience, but an investment in the shares could prove very profitable in the long run and, with a dividend yield of more than 3%, it can provide a source of growing income. The shares have rarely been so cheap and the runway for continued successful growth looks promising.
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